Kirby Corporation (NYSE:KEX)
Goldman Sachs 2012 Industrials Conference
November 13, 2012 11:45 AM ET
Joe Pyne – Chairman and CEO
David Grzebinski – EVP and CFO
Tom Kim – Goldman Sachs
My name is Tom Kim. I’m the lead transportation analyst for Goldman Sachs. It is my pleasure this morning to host the session with Kirby. I’m privileged to sit here with the Chief Executive Officer as well as the Chief financial Officer. Joe Pyne will lead us off, Joe is the CEO of Kirby, the nation’s leading inland and offshore tank barge operator and David Grzebinski will also present on the financial aspects of the company. And after about 25 minutes of discussion, we will go into Q&A.
Without further ado, I will turn the floor over to you Joe.
Okay, thank you, Tom. We are competing with the watch here. Kirby is in two businesses, we are in the marine transportation business and the diesel engine service business. Almost two thirds of our current revenues are in the marine transportation area and about a third in the diesel engine service area. We are exclusively a barge operator both in inland and coastal barge operator. So we will come back and drill down into these areas later in the presentation.
Just some public facts about Kirby, approximate market cap with $3.1 billion, enterprise value a little less than $4 billion, employee about 4400 people. The Kirby specific facts, we are the largest inland and coastal barge operator in the United States by a significant margin. About 75% of our inland revenues are under contract a year or longer. On the coastal side, this is really driven by the fact that the coastal sector is in a little different place in the recovery cycle than the inland sector, about 60% of the revenues are under contract a year or longer; 90% of those revenues are under time charter; on the inland side, it’s a little less, it’s about 58%. We would expect over time that the coastal revenues under contract would rise to levels at least where the inland contracts are.
On the diesel engine side of the business, we are a national service and parts provider of really the core engines that are used both in the marine applications but also in power servers and power generation application that need speed engines and high-speed engines. We also assemble, manufacture and remanufacture oilfield equipment, equipment that’s really used to extract oil from shale formations, high-pressure pumpers and associated equipment with that. We are an aggregator and consolidator in both those spaces, 31 marine transportation acquisitions since the middle 80s and 16 diesel engine acquisitions.
This looks at the marine transportation acquisitions, the most recent one being a coastal acquisition, Allied Transportation which was done first of this month. There are still some shippers engaged in this business, we have indicated them in red on the slide. What’s been happening is over time shippers have been outsourcing their fleets, we bought Union Carbide’s fleet, Dow’s fleet, (inaudible) chemical fleet, and Exxon’s fleet and some smaller fleets. But we think that the general trend has is going to be to outsource from the shipper community.
This looks at the diesel engine acquisitions, the largest one being the United Holdings which we did last year and we have announced, I don’t think we closed yet, Applied Services.
Revenue growth since 1988, over 16%; an impressive revenue growth with respect to earnings growth of about 15%. This goes back to 1994, we had a discontinued operation that we adjusted our earnings back to ‘94. We sold really an offshore piece of the marine transportation business in the late ‘90s.
Drilling down to the transportation side of the business, the inland waterway system of United States, a very extensive system, 12,000 miles of navigable waterways, navigable because of the series of locks and dams that maintain water levels to navigation drafts.
This is our inland operating system. On the coastal side, our operating system is shaded and blue and it’s the three colors as well as Alaska and Hawaii.
Some facts about the barge business. This is an industry that services the areas that I pointed out on the map. On the inland side, it is comprised of really two segments, a dry cargo segment which is a much larger segment – excuse me, a the tank barge segment which is the segment we are in. We are in the tank barge segment not in the dry cargo segment for a reason. We think that the tank barge side of the business is a business that you can actually add value. You are competing on price and availability but you’re also competing on your safety record, your ability to be flexible and reliable with respect to the service offering. You’re working with companies who really do care who the (inaudible) of your cargo is because of the reputational risk and liabilities that could be attached if there was a problem. In fact, the dry cargo business on the other hand is really availability and price, so it’s hard to add value to that.
On the coastal side, again we are the largest operator in this business but as you look at the industry population of barge users, we are defining it at about 185,000 barrels such that the part we are in and below. There are 270 barges in this universe.
The Jones Act protects this business, there is no foreign competition. Jones Act requires US built, US owned and US proved vessels. Really no economic obsolescence other than the single skin, double skin issue. With respect to Kirby, on the inland side of the business that’s behind us; on the coastal side, we have I think three small single skin barges that are still in operation. Those barges will have to come out of service at the end of 2014.
Barges are mobile, it’s not like a fixed facility ashore. The market goes away, in one area you can lose the barge, unlike tank a form (ph) for example, very important part of the US economy and also an environmentally friendly way of moving cargos around, excellent safety record, low carbon footprint, fuel-efficient, just a number of things going forward.
This looks at the demand drivers and this is our revenue in its entirety on the inland side of the business, almost 70% of revenues are associated with chemicals. When you add it to the optional side of the business, you dilute that. So a little over 50% of what we do is in the petrochemical area, 25% refined products, 18% black oil and little less than 5% agricultural chemicals.
With respect to the black oil business, that is actually growing. The need to transport liquids out of the shell formations is a new source of demand for this business and you’re going to see it continue to grow and absorb capacity.
Because of who we work for and what we carry safety is an important part of our service offering and as the largest operator in both these spaces, we think that we have a very strong safety reputation as well as record.
Drilling down into the tank barge sector, the inland tank barge sector, this is looking at supply, really stable – through last year, we think in 2012, supply will grow, we think that it’s being absorbed, we think it’s necessary to meet demand based on increased volumes of petrochemicals and based on the increased volumes of black oil or shale formation liquids that are being transported.
This is the age profile of the fleet, still relatively mature. You also have replacement building that’s occurring. In the Kirby fleet, most of the building that we are doing is replacement building and in fact, we have driven our age profile down over the last four years by about six, seven years just by aggressive replacement program when shipyard prices were very attractive.
We think that size matters in this business, we enjoy some economies of scale that small operators do not enjoy. We have some operating efficiencies that we can capture those small operator can’t capture. This looks at those, part of it is, the more cargos you control, the more backhauls you could put together. The more power you have in your system, the better you can pick up, move barges, drop them. The closer you are going to be to the cargos that you have to move and the likelihood of having a barge in your fleet that doesn’t require to be cleaned, it already has a compatible last cargo bottom is a lot higher in our larger fleet. And in the tow boat area, we have a model that really charters about 25% to 30% of the power we need to move our barges, this allows us to downsize very rapidly in a downturn. Good example of that was in 2009 where we dropped a lot of power, a lot of cost and actually saw in a very stiffly declining market, our margins improved, given our flexibility in that area.
This looks at who is left in the business. These are the companies we haven’t bought yet and we could get these all those opportunities, the shippers are again in red. We think that this is a business that will continue to consolidate that we plan to be a consolidator in this space. Now the issue here is that since the really the bottom in 2009, rates really have risen to peak levels, we are back at peak pricing levels in this sector. And when that happens, asset pricings raise. So we haven’t been as aggressive in the inland tank barge sector as we have in the coastal sector which I will come to in a minute, and it’s because price does matter. When you are a consolidator, you bought a lot of assets. What you pay for those assets, long-term, frankly is a large part of your success. You overpay for something, it’s with you forever.
I am going to move to the coastal sector. Again, we are the largest operator in this sector. Our fleet is little less than 5 million barrels of capacity. This does include the purchase I noted of Allied Transportation which was principally an offshore coastal petrochemical transporter and they did have a dry cargo operation and three large offshore dry cargo barges. We don’t talk about it a lot but it’s a relatively small part of what we do, but Kirby has four offshore dry cargo barges that we are engaged in moving coal from the lower Mississippi River to Florida and aggregate back to Movil for cement manufacturing purposes. We have two more barges under construction in this area. So that’s a fleet that’s growing and it was synergistically what we got from Allied.
We operate on all the coasts, and Alaska is why as I pointed out earlier, we think that the dynamics, the fundamentals of this business are moving into line, we think that capacity has been absorbed in the transportation of the shale liquids and capacity has also been removed from the business as older equipment has been retired. About 80% of this fleet is still single hull, again that part of the fleet is going to have to be out of service by the end of 2014. So we think the opportunity for margin growth is very good here. We also think that there is opportunities because of where they are and their cycle for acquisitions and our focus from an acquisition perspective has been in this area really three acquisitions since middle of last year with the opportunity to do more and I talked about the single hull requirement.
This looks at kind of who is in the business by number of barges. Vane has a number of barges but they are mostly smaller. The companies are going to be more equivalent, those are going to be the Bouchard and Reinauer operate a slightly bigger barge.
Moving on to the diesel engine business, we are in the land based business servicing engines that are principally used in land based oil service operations and the marine business which these are legacy business, the power generation is part of this legacy business also but it’s a – that business that works for companies like Kirby works for this tow boat business, the offshore oil service business. Then on the power generation side, we are the nuclear distributor for a couple of engines, which is a great business.
Due to the engines that we maintain, you will recognize the name in high-speed area, it’s Cummins and Caterpillar, Detroit Diesel and that kind of engine.
On the land based side, which is about 70% of this business, we are really focused on servicing engines that are part of shale formation energy recovery. The engines are used in a high pressure pumping operation for other equipment that cementers, double pumpers, other equipment that’s used in this business. Now when we bought this company, it was principally assembling and manufacturing this equipment and what we saw was a great opportunity to harvest what we saw a great service annuity of the number of engines and the amount of equipment that has been kind of frown at this market in the last four years. This is a business that has grown exponentially and really the service of this equipment is just now becoming a reality. So we bought United to position ourselves to do that to provide the kind of services that we do with our legacy business. I think that that’s coming along well and our focus is going to be to really concentrate on this area. The other thing that I will just note with respect to engines that are used in this market is that the application is a much more strenuous than in a diesel – in a marine compulsion environment, the overhaul cycles are almost twice but they would be – if the same engines were used in a marine application.
This – a great article in the Wall Street Journal, which I am sure most of you saw, this morning that the US, who would have imaged this even a year ago either depending on who you listen to, either in 2017 or 2020 is going to be the largest energy producer in the world, surpassing Saudi Arabia and Russia. And the reason for this is the energy trapped in the shale formations. This was important for our land based diesel engine business, it’s also important for marine transportation business. As the transportation requirements that are coming out of the need to move these, particularly these liquids to where they are being processed are significant both from a coastal perspective but also from a diesel engine perspective.
We put this in here, I think this the slide that most of you are aware of but it really makes the point that you can do this safely, it’s well below the water table. I think that the nation is beginning to move to a view that this can be done safely and it certainly represents a great opportunity for this country in terms of job growth, energy independence and manufacturing, returning to this country which is all good for the core businesses that we are in, transportation and diesel engine services.
Moving on to the outlook for the fourth quarter, we are forecasting a range of $0.83 to $0.93 a share, that’s compared to $1 for fourth quarter last year. The fourth quarter of 2011 was very, very strong quarter for the manufacturing side of our diesel engine business and that pretty has died. So that’s the principle difference between the quarters. If you look at the transportation sector and the legacy diesel engine business, they are actually going to do better, this quarter compared to the quarter before.
In terms of the fundamentals of the transportation business, utilization rates excellent on the inland side that we are projecting those to continue, we think that we are going to continue to get some escalation as we renew contracts and we think that the coastal side is now positioned to begin to see margin expansion, higher utilization and just a better business environment.
On the diesel engine side, we talked about the demand for new oil field equipment but that’s somewhat offset a better environment in the marine service side of the business and in the power generation side.
For the year, we are forecasting a range of $3.53 to $3.63 compared to $3.33 in 2011.
Now I am going to turn the mic over to David to talk you through the financial side.
Thank you, Joe. I will just hit on a couple of quick financial slides. This is my chart here, just to point out a couple of numbers, the revenues on the top there, marine transportation, diesel engine services, you see the year-over-year change from third quarter, you see marine transportation revenues were flat, diesel engine services down about 20%, that’s from the, as Joe mentioned, the slowdown in the new manufacturing of frac engines and frac spreads. If you look at the profitability, you see marine transportation was actually up in terms of profitability on flat revenues and it’s basically pricing and utilization particularly in the inland space as our utilization is very high in the 90% to 95% range.
Profitability is down at diesel engine services on the lower sales as volume falls off, you get a little less fixed cost pickup. And I just wanted to point that out, this is nine months ended, I am not going to go into that.
Let’s spend a few minutes on our margins, operating income margins by the segments. The yellow line are the marine transportation margins, the red line is diesel engine services segment margins.
Couple of key takeaways. If you look at the marine transportation line, you will see the left major trough started in 2000 and kind of ended in 2003 where we were around 15% operating income margin. This last economic cycle which began in the third quarter of ‘08 takes a while to roll through our contracts, you see in 2010, we hit trough margins about 21%, actually one quarter we were below 20%. So what’s the key takeaway. One, this economic cycle was much shorter than the last one but more importantly for us, you will see that our trough margins are much higher this last cycle than they were the prior cycle. And there is a couple of reasons for that. One, during the 2006 through 2008 timeframe, we restructured our inland marine business and took about 22% of shore staff out, got much more efficient and how we do business, and also, as Joe mentioned, we leverage our horsepower and try and utilize charter horsepower. So we don’t own all of our tow boats, we charter in about 25% of our tow boat usage in. What that allows us to do is when demand fluctuates and goes down, we can lay off charter tow boats very quickly and keep our margins higher versus if we owned it, you would have the capital tied up, you would have to severe the people and lay them off and hire them back as business fluctuates. So we use the charter tow boat arrangement as part of our horsepower to manage fluctuations and demand and that’s kept our margins up.
If you look at 2011, you will see the margins started going up. Part of the reason they didn’t go up as high as you might have expected given the robustness of the inland business being 90% to 95% is we purchased K-Sea Transportation which is an offshore company, they are at a different point in the cycle, the coast rise barge business is at a different place in its business cycle than the inland barge business. The coast rise business peaked in ‘07, ‘08 and then with the economy turning down, refined products volumes dropped pretty heavily. So coast rise demand for movements of refined products fell off considerably. Utilization in the coast rise business went from 90% range down to the low 70%, and may have even gotten below 70%, so margins have fallen. And unlike in the inland business where we have seen a lot of petrochemical demand and more crude moves, it hasn’t hit the coast rise business as much, coast rise moves a little more refined products. So the coast rise business margins are just now starting to come up, they peaked in the mid-teens for K-Sea. In 2010, it was about breakeven, they are mid-single digits for most of this year, this last quarter for us they were in a high-single digits. When you average that in with the inland margins, it’s depressing margins. If you were to look at just inland margins on the yellow line, it would be up in the mid 20%, around 25%.
On the red line, the diesel engine services, fairly steady business. You will see the higher margins in ‘06, ‘07, ‘08 timeframe, that’s when the Gulf of Mexico was doing very well, we were repairing a lot of offshore equipment, a lot of offshore engine equipment, we do think the business long term should be a mid-teens business but it’s kind of steady particularly given the downturn in our United business with the slowdown and the manufacturing of frac spreads.
This is just to give you a feel of the cash flow generation capability of the company, this is EBITDA per share, it has grown nicely over the last several years and well, pretty long-term – a good track record there as well.
This just gives you a feel of free cash flow generation, the green bars are cash from operations, the yellow bars are capital expenditures. The point of this slide is that the green bars are always in excess of the yellow bars. We have, as Joe mentioned, had spent a lot in capital spending on replacing our fleet, we’ve taken the average age of our inland fleet down from about 24 years old to I think at the end of this year will be 16 years old in our inland fleet. So we have reinvested in the fleet when shipyard pricing was low and we’ve also as Joe mentioned, building a couple of offshore units which is driving it up.
You should see our capital spending coming in the next several years, it will come down quite a bit in 2013 and then even further in 2014 as our capital spending and replacement barges slows down.
This gives you a feel for our balance sheet, debt-to-total cap. We are right around 32%, 33%. The point of this slide is, as Joe mentioned, we are a consolidator, we do acquisitions. You see the blips up in our debt-to-total cap, it’s been acquisition driven. We tend to do acquisitions and then delever. We believe that it’s important to have an investment grade balance sheet because we invest counter cyclically. We like to be in the shipyards when nobody else is, we like to buy companies when they are out of favor or industry dynamics or such that it’s tough and you can get a reasonable price at a reasonable multiple.
And I guess this just kind of summarizes that financial point of view. If you look at our ratings, we are A minus at Standard & Poor’s, Baa3 at Moody’s and you can see our revolver and our debt profile there. Suffice it to say, fairly strong balance sheet, we are probably, to my knowledge in the US marine space, they only investment grade company out there.
With that, I will turn it back to Joe for a summary.
I think we managed to eat up all the time but we have time for a couple of quick questions.
(inaudible) customers in business. Are you payments – aren’t you revenue based and volume or is there any contracts tied to the underlying energy prices?
No, it’s – on the transportation side?
No, we never tie a contract to energy prices, it’s way too volatile (inaudible) business that way. We have a number of different structures with respect to contracts. But generally there are time charters where a customer takes the unit under charter on a daily basis and pays X dollars a day where there are affreightment contracts where you get paid on delivery, either by the number of barrels it delivers or tons.
You talked about fleet age, about years in the industry. Are the newer ships, I am sure they are safe, how much cheaper are they to operate?
Well, short terms are cheaper because you don’t have maintenance expenditures but as they mature and get 25 to 30 years old, then they get practically (ph) more expensive. What we have done with our fleet is we have moved it from 24 years in age which was about the industry average down to the end of this year about 16 years. So it’s a significant reduction. New barges are going to be a little less expensive but cost more than older barges. So you have more depreciation on its maintenance than the newer barge. Older barge you have more maintenance (inaudible) depreciation.
Is the anti-trust a significant obstacle for you in the consolidation of the inland tank barge business? It looks like you have a quarter of the current US fleet of inland barges.
We have about, I think, 27% and – we don’t think so because of who we work for – our largest customer is Exxon and it’s hard to get – miss the (inaudible) about Exxon’s concern for a company like Kirby and they will just go and do it themselves if you don’t treat them right. And we think that in the oil service area as you look at companies with large market shares that work for our customer base, they are significantly higher than us. You have some people in the oil field every year that have over 50% market share. We think that you can get somewhere between 40% and 50% of that market and still be okay from an anti-trust perspective. It’s a political process unfortunately. So it’s going to depend on when – who is in charge when you get to those levels but we do think we have ways to go.
Just a separate question on crude black oil. Is there better economics potentially bringing heavier crudes and landing them up the Mississippi by rail and then putting them on a barge and moving them down to the refining complex rather than going rail all the way?
No, that’s happening, particularly for Louisiana based refineries where you can get to the river, put it on a barge and bring to the refinery where you see less of that is crude oil going to Houston from the Balken but crude oil coming out the Eagle Ford which is in South Texas, a lot of that’s moved by water. It just depends on where it is.
Is the insulated market growing for heavy oil or is that pretty minor?
Heated, I guess.
Yes, that’s (inaudible) asphalt, it’s stable, I wouldn’t say it’s growing. Some of this Canadian crude has to be cut, move it, it’s very heavy stuff but it’s for the most part has not moved into any barges.
If I could ask one last question, just with regard to capital allocation. As you CapEx requirement has come down, how do you foresee deployment of your excess free cash flows?
First thing we do is delever a bit. We would still like to do some more acquisitions, we think of the coast rise space, there is still some opportunity because where they are in the business cycle. So hopefully we can get one or two in in the near term, which may push our debt up a little bit, then we will use the free cash flow to delever, prepare for the inevitable down cycle. Nobody likes a down cycle but actually it sets up for us to be able to do more consolidation. So we try and get our balance sheet in the right space. That said though, we have repurchased a number of shares. I think since Joe’s been Chairman, we’ve repurchased about 22 million shares or something?
Over a period of time. We have looked at the dividends. We talk, we discuss it with the board. At some point we may get to a size where we could do both and continue to consolidate and maybe pay a modest dividend but right now in the near term it will be to delever.
Now the application of capital is it shouldn’t be done opportunistically. There are times to buy assets, there are times to delever, they are times to buy back your stock and there will be a time to issue dividend and the dividend policy but we’ve been very opportunistic in how we deploy our capital over the last 25 years.
Okay, thank you.
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